Miller v. HCP & Co., 2018 WL 656378 (2018)

Facts

  • Christopher Miller founded Trumpet Search, LLC (Trumpet) and held membership interests that were junior to certain preferred unit classes.
  • HCP & Company and affiliated entities held most of Trumpet’s Class D and Class E membership units.
  • Trumpet’s operating agreement set a sale-distribution waterfall that prioritized HCP’s units: Class E was entitled to a 200% return first, and Class D was entitled to a 200% return second.
  • Because of the waterfall, HCP would receive most of the first roughly $30 million of sale proceeds before junior members received meaningful distributions.
  • The operating agreement’s only express sale-related requirement was that any sale be to an unaffiliated third party.
  • HCP controlled four of Trumpet’s seven board seats, and a sale could be approved by a majority vote of the board.
  • The operating agreement included broad waivers of fiduciary duties by members and managers.
  • About seven months after the operating agreement was signed, the HCP-affiliated board members stated they intended to sell Trumpet to MTS Health Partners, L.P. (MTS) for approximately $31 million.
  • HCP gave the non-HCP board members five days to find an alternative offer.
  • The non-HCP board members obtained an alternative offer for $36 million, after which MTS increased its bid to $41 million.
  • The non-HCP board members also obtained a letter of interest valuing Trumpet at approximately 50–50–60 million.
  • The board ultimately approved a sale to MTS for just under $43 million.
  • Under the waterfall, members outside Classes D and E—including Miller—received little or nothing from the transaction.
  • Miller sued, claiming the implied covenant of good faith and fair dealing required the board to conduct an open-market or auction process to maximize value for all members. HCP moved to dismiss.

Issues

  1. Whether the implied covenant of good faith and fair dealing can be used to imply a requirement that Trumpet’s board run an auction or other value-maximizing sale process when the operating agreement waives fiduciary duties and requires only a third-party sale.
  2. Whether the complaint identified a specific contractual gap that could support implying additional sale-process protections beyond the agreement’s express allocation of board authority and the bargained-for distribution priority.

Decision

  • The Court of Chancery granted the defendants’ motion to dismiss for failure to state a claim.
  • The court held that the implied covenant could not be used to add an auction or Revlon-like, value-maximizing sale-process obligation where the operating agreement addressed the sale framework (including a third-party requirement and board authority) and where fiduciary duties had been waived.
  • The Delaware Supreme Court affirmed by order.
  • The Supreme Court noted that contractual “sole discretion” does not eliminate the implied covenant, but agreed that Miller had not pleaded a contractual gap supporting an implied term requiring a different sale process.

Legal Principles

  • Delaware LLC members may waive fiduciary duties by contract; when they do, the operating agreement is the primary source of rights and obligations.
  • The implied covenant of good faith and fair dealing is a limited doctrine that fills true contractual gaps for unanticipated circumstances; it does not rewrite a detailed bargain or supply protections the parties did not include.
  • A plaintiff asserting an implied-covenant claim must identify (i) a specific gap in the contract and (ii) a specific term that the parties would have agreed to at the time of contracting.
  • A contractual grant of discretion does not eliminate the implied covenant, but the covenant generally will not be used to impose sale-process requirements (such as an auction) absent contract language indicating the parties meant to restrict how a sale would be conducted.
  • Courts will enforce bargained-for capital structure and distribution priorities even if those terms cause junior holders to receive minimal proceeds in a transaction approved under the agreement’s governance rules.

Conclusion

The Court of Chancery dismissed Miller’s implied-covenant challenge because Trumpet’s operating agreement waived fiduciary duties, established a distribution waterfall favoring HCP’s preferred units, and required only that any sale be to an unaffiliated third party, leaving no contractual gap for the court to imply an auction or other value-maximizing sale process; the Delaware Supreme Court affirmed that dismissal by order.